While he'll convince no one in love with Big Government of his thesis, the American Enterprise Institute's Peter Wallison is making the case that recent academic research supports the proposition that Dodd-Frank and other regulatory burdens imposed by the federal government in the wake of the economic recession of 2008 are hampering the economic recovery of the U.S. (hat tip to a community bank CEO and blog reader for sending me the link).
First, a study by Michael Bordo and Joseph Haubrich showed that recoveries after financial crises are actually sharper than other recoveries. After studying 27 recession-recovery cycles since 1882, they concluded that “the stylized fact that deep contractions breed strong recoveries is particularly true when there is a financial crisis.” So we should have expected a steep recovery after the sharp 2008–09 recession rather than the stuttering and stalling economy we have experienced.
Also, studies of Dodd-Frank’s effect have shown that the regulatory burdens imposed by that law have been particularly harsh for community banks. The Fed defines community banks as banks with $10 billion in assets or less; 98.5 percent of all US banks fall into this category. A 2012 Government Accountability Office study showed that 7 of the 16 titles in Dodd-Frank had potential adverse effects for these banks, and studies by scholars at George Mason University and Harvard’s Kennedy School have found significant compliance cost increases attributable to Dodd-Frank. “Since the second quarter of 2010,” said the Harvard study, “around the time of [Dodd-Frank’s] passage, we found community banks’ share of [US banking] assets has shrunk drastically—over 12 percent.”
Of course, the regulatory costs to community banks are not a new story; Congress has been attempting to mitigate these costs for years. What is new is the data that shows the effect of these regulatory costs on small business and hence on economic growth.
Wallison asserts that the vast majority of small businesses (traditionally, the primary drivers of job growth) require bank financing because they do not have the access to capital markets that larger business have. Increased regulatory costs mean less credit. Less credit means slower growth. Slower growth means less job creation.
This is where the costs loaded on small banks begin to affect US economic growth. Regulatory costs affect small banks more than large banks because the costs are largely fixed and large banks by definition have a bigger asset base over which to spread these costs.
When a small bank is required to hire a compliance officer, that is an employee who is not making loans or producing revenue. When the Consumer Financial Protection Bureau—set up by Dodd-Frank and the bane of small banks—sends out a 1,099-page regulation on mortgage lending, that means a community bank must engage a lawyer to interpret the new regulation, a compliance officer to apply the regulation in individual cases, and a tech firm to retool its mortgage underwriting system. All costs, no revenue, and fewer funds to lend. When a bank examiner criticizes a loan because the bank does not have audited financial statements for a customer who has never missed a payment in 20 years, that forces a bank to revise its business model and change its customer relationships. Again, costs for the bank and less financing for the small business.
If the costs Dodd-Frank has imposed on small banks are hurting small business, we should see a significant difference between the growth rates of small and large businesses since 2010. That is exactly what the data shows. In a Goldman Sachs report published in April 2015 and titled “The Two-Speed Economy,” the authors found that firms with more than 500 employees grew faster after 2010—the year of Dodd-Frank’s enactment—than the best historical performance over the last four recoveries. These firms largely had access to the capital markets for credit. However, jobs at firms with fewer than 500 employees declined over this period, although this group had grown faster than the large-firm group in the last four recoveries.
Here, then, is the source of the slow recovery from the 2008–09 recession. Although 64 percent of net new jobs in the US economy between 2002 and 2010 came from employment by small business, this source of growth has disappeared since the enactment of the Dodd-Frank Act. While larger firms have access to credit in the capital markets, millions of small firms, limited to borrowing from beleaguered community banks, are not getting the credit they need to grow and create jobs.
As I said above, Wallison won't convince the Bernie Sanders/Elizabeth Warren crowd with facts. One of the commenters to Wallison's article makes this point ably.
To blame the slow recovery on Dodd Frank is frankly hilarious. It defies logic. Big banks were the major contributors to the 2008 recession and their failure to re-inflate the lending system after the government had made them whole will go down as one the major acts of treachery against small business. Small banks are doing poorly for a far different reason. See the growth of a strong aggressive regional banking structure.
You'll notice that, unlike Wallison, no studies or statistics are cited by the commenter to back up his arguments or even his factual assertions, nor to counter those that support Wallison's arguments. Instead the basic ad hominem attack is made that Wallison's position is "hilarious."
No, it's anything but "hilarious." As people who have actually made a career in the community banking business understand, it is many things, but "hilarious" is not among them.